European turmoil, American collateral

For the US, the risk of damage from the eurozone's crises is not primarily economic, but political. But there is opportunity, too

The Dutch prime minister, Mark Rutte, walks into the Royal palace to tender his government's resignation. The fall of the coalition was part of the political instability that made traders sell the euro on Monday. Photograph: Robin Utrecht/EPA

In the Netherlands, the center-right government of Mark Rutte fell, unable to cobble together a coalition to pass budget cuts required by EU fiscal rules – rules that mandate that eurozone countries run annual deficits no more than 3% of GDP, which would force stringent austerity upon the Dutch to bring down a deficit that is currently projected to be 4.6% of GDP in 2012. Rutte, along with Merkel of Germany, was a hardline advocate of the 3% fiscal discipline rules.

But given that the sober Dutch are in no danger of defaulting on their AAA-rated bonds, why the turmoil and panic? Because, perhaps, the Dutch are indeed sober – and a significant number of them have said "enough". Having seen the devastation inflicted on the Greek, Irish and Spanish economies by tough austerity measures, many have concluded that the pain is simply not worth it to meet an arbitrary 3% deficit rule.

Moreover, Greece, Ireland and Spain have shown that meeting a deficit number in a depressed economy is akin to chasing a moving target: because budget cuts depress the economy, to achieve a one percentage point of GDP reduction in the deficit requires cutting by more than one percentage point. And when one misses one's target, even more cuts are necessary. Better, then, not to go there at all, reason the Dutch.

When markets contemplate that it's likely that another austerity-skeptic, François Hollande, will win the presidency in France, then the pattern becomes impossible to ignore: the "core" eurozone countries are fragmenting. While it would be foolish to make predictions, what is probable is that Germany's political isolation within the eurozone will deepen, leaving German taxpayers unwilling to continue backstopping the whole system.

What are the implications for the US, economically and politically? Direct links between the US and eurozone economies are fairly minor: we don't export that much to them, they don't import that much from us, and US banks have had an extended time to cut their exposure to eurozone risk. Yet the collateral damage could still prove significant.

When the stock markets fall, consumer and business confidence falls, leading to cutbacks in spending – bad news for an American economy that is still mired in recession. In addition, crisis in Europe makes for a stronger US dollar, as investors flee to safer abodes. Again, bad for the economy as a stronger dollars hurts US exports.

The reality of the eurozone's troubles should lend support to President Barack Obama's campaign against GOP presidential nominee presumptive Mitt Romney and congressional Republicans. It provides a demonstration that austerity is self-defeating, that fiscal stimulus is needed in a deeply depressed economy, that recovery from a financial crisis is a slow and halting process, and that by grasping the nettle immediately, the Obama administration has succeeded in stabilizing its financial sector – while the Europeans have made a hash of it.

Yet politics, especially in America, is never so easy. As with his recent campaign stop in which he blamed Obama for a factory closing which actually occurred during the Bush administration, Romney will blame Obama for every problem – no matter how tortured or fraudulent the logic. It would be a great irony if Obama, who has been far more supportive of expansionary fiscal policy than any European leader, is hurt by the blowback from austerity in the eurozone. But this is what can happen when voters are in a foul mood and opponents are unencumbered by the truth.

There is, however, another outcome possible. In this alternative, continued economic troubles force Obama to sharpen his game and focus on principles, in which he gives a robust defense of fiscal stimulus, of the importance of the social safety net, explains how government spending can be a force for good. In fact, the events of the past few years have almost uniformly supported Obama's world-view and Democratic policies. But in order to win in November, he must fight for them now.